Economics

Tech booms

Too hot for jobs

THE financial press went ape this week over the highly anticipated IPO of one Facebook, the Harvard social network turned $100 billion phenomenon. Facebook's soaring valuation has focused attention on a Silicon Valley that is once again booming, and it has led many to wonder whether social networking isn't inflating into yet another tech bubble. Nifty little online diversions with often questionable long-run revenue potential are increasingly trading hands for enormous sums of money—Instagram, Pinterest, Groupon, and so on. Maybe these companies are overvalued and maybe they aren't; I'm in no position to say. It is probable, however that—just like in the late 1990s—meaningful innovation and economic growth are occurring beneath the froth. The 1990s gave us scads of dotcom flops, but it also gave us businesses like Amazon and Google: companies that are fundamentally changing the way the economy works. This boom, too, will have its extraordinary, transformative firms.

Could it also bring back the roaring labour market of the 1990s? An interesting new paper by Enrico Moretti and Per Thulin estimates the employment multiplier on job growth in different industries and finds that in America, a new job in the manufacturing sector of a city corresponds to an addition of 1.6 jobs in its non-tradable industries (things like eateries, education and health services, salons, landscaping, and so on). For high-tech employment the multiplier is much higher, however; 5 jobs in non-tradable industries are generally created for each job in high tech. That seems a plausible relationship. Yet when we look at individual cities and regions, we see substantial variation. And what is particularly striking is just how limited the immediate employment impact of Silicon Valley's boom appears to be. From 2009 to 2010, the San Jose metropolitan area economy grew some 13% but employment in the metro area rose about 2%. The Houston metro area enjoyed job creation equally fast on much slower economic growth, of just 1.6%. (We won't get data on 2011 metropolitan economic growth until this fall.)

Attempting a back-of-the-envelope version of the Moretti-Thulin calculation, we see similar results. The San Jose metro, for instance, experienced a private employment rise of about 30,000 in the year to April, of which just over 5,000 came in "professional, scientific, and technical services", which includes some but not all high-tech employment as well as some things that aren't high-tech. In Houston, by contrast, private job growth amounted to 90,000 in the year to April on just 7,000 in professional, scientific, and technical services. Houston, in other words, got about twice as much private job growth out of its technical job growth in comparison with San Jose. If you repeat the exercise at the statewide level, for California and Texas, you get a similar ratio; Texas produces many more overall jobs for a given number of skilled, tech positions. This doesn't just come down to cyclical government employment changes, as it happens. Early in the recovery California was losing far more government jobs than Texas, but in the year to April government losses were roughly proportional in the two states.

An important question would seem to be why Texas creates so many jobs relative to California, or why California creates so few given its booming tech sector. Alternatively, one might wonder or worry whether something about California's economy isn't potentially stifling the development of a wave of innovation.

Last week, Tim Lee discussed a story in Wired which describes a venture capitalist who is souring on investment in Silicon Valley. The Wired story reads in part:

As an investor Hartz points to the usual signs of too much money-chasing deals. The billboards on highway 101 between San Francisco and Silicon Valley touting startups no one has heard of. The bus stop signs in tech-heavy locales like Mountain View and Palo Alto advertising scads of engineering jobs.

“Everyone is competing for the same people, going after the same real estate, the same support services,” Hartz says. “The natural resources of the startup world are getting scarcer and scarcer, and the cost is getting higher and higher. It's all an outgrowth of an abundance of capital.

There is more interest in investment than resources to put such investment to work. But, asks Mr Lee, why should that be the case? Why isn't there enough real estate and talent in Silicon Valley to put available capital to better use? Why, instead, does capital simply bid up prices of existing resources?

The limits, as Mr Lee says, are artificial:

Hartz suggests that the limited supply of real estate is limiting the growth of the tech industry. Obviously, land is finite but apartments and office space need not be. San Francisco has plenty of room to build upwards. Silicon Valley wouldn't even need to build upward—it could dramatically expand its housing stock simply by allowing the construction of more duplexes, row houses, and low-rise apartment buildings.

Economist Jed Kolko makes a similar point. He notes that in the year to April rents rose 5.6% across America as a whole. Over the same period, they rose 10.1% across all of the San Francisco Bay area and 12% in the "Facebook Metropolitan Area" (that is, the 10-mile circle surrounding Facebook's Menlo Park headquarters. Mr Kolko adds;

[B]ecause Facebook is in the Bay Area, its IPO will create losers. Here's why. If Facebook were in Texas or North Carolina, developers would have been building new homes in anticipation of this day. But in the Bay Area, water and the hills leave little land for development: the area in the bay under the Dumbarton Bridge would be an easy commute to Facebook if you could only build housing on the water. In addition, building regulations make development difficult on the precious flat land that exists. As a result, little new construction is underway in the Bay Area – far less than in other metros with similar job growth.

A growing economy and rising wealth should attract lots of new people to work, start businesses, and provide services. Because it is very difficult to add to the area's real-estate capacity, rising wealth translates instead into a bidding war for existing real-estate resources. That translates into much higher prices and rents for the dwindling pool of available housing and office space. Much of the gain from the region's booming, innovative economy accrues to landowners who are able to earn rents thanks to real-estate supply limits. The Bay Area certainly faces geographic limits on development—including the Pacific Ocean, the Bay itself, and the occasionally steep hillsides that surround the area. At the moment, these are not the binding constraints on the region's growth, in terms of square footage or population. Regulations are. Consider the case of Google.

Google is located in Mountain View, just a few miles southeast of Palo Alto. Its headquarters is in the North Bayshore portion of the city, a piece of land tucked between Highway 101 and the Bay, in an office park that the giant firm has been slowly devouring. Google's buildings are all high tech on the inside, but on the outside they're standard late-20th-century suburban office park: clusters of short buildings surrounded by acres of surface parking. The land on which Google is sited could contain vastly more office square footage with plenty of room left over for thousands of residential units. Neither geography or geology prevents this; one finds buildings that are much taller in downtown San Francisco and San Jose, to Mountain View's northwest and southeast, respectively.* The obstacle is regulation. The land simply isn't zoned for denser construction.

As it happens, that's a source of frustration for Google itself. The company has been working with the city of Mountain View to try and gain approval for redevelopment of its North Bayshore land to include denser buildings laid out more like a city grid and less like an office park—and to add housing. Google's efforts in this area aren't necessarily motivated by a desire to boost the region's overall housing capacity; the company is more interested in accommodating its workforce, many members of which would prefer to do less driving and spend less time commuting. Many also prefer walkable urban environments to the more suburban neighbourhoods common in Silicon Valley. A healthy number of Google's workers now live in San Francisco for precisely that reason—to enjoy the lifestyle and consumption benefits of a typical city—and are ferried to Mountain View each day by Google's own shuttle service. Given this set of needs and preferences, better use of Google's land makes perfect sense, for Google and the region as a whole.

And yet its plan has repeatedly bumped up against local opposition. Some of this opposition is motivated by environmental concerns related to construction close to vulnerable bayshore. That's understandable if a little overcautious given that Google would like to redevelop land that is already in active use. Much of it is motivated by a more prosaic NIMBYism—a desire to limit change for fear of potential negative impacts on quality of life.

In April, Mountain View's city council voted to reject Google's proposal. The matter is not yet settled; Mountain View's Environmental Planning Commission voted this week to overturn the council's rejection. But this episode illustrates the challenge in attempting to loosen supply restrictions in the Bay Area. Google is a world-beating technology company, a magnet for money and talent. Many cities would fall over themselves to accommodate it, would rewrite zoning codes, offer massive tax incentives, and rename themselves Googleville if need be. Not the Bay Area. Few men not named Steve Jobs have been able to have their way with the development-averse cities of the world's leading tech centre.

Of course, Google could go elsewhere. As Mr Kolko says, other places with freer development rules would accommodate the company's needs and associated housing demand and then some. And indeed, some tech firms have relocated to or opted to set up in places like Raleigh, North Carolina and Austin, Texas. Los Angeles and Seattle are strong rival tech centres, as are Washington, Boston, and, increasingly, New York. As welcome as growth in those cities is, however, it is no substitute. If it were, Google's decision would be an easy one. Silicon Valley is unrivalled, however, as a labour market and innovation hub. To be there is to be more productive, more competitive, and more plugged in to the latest industry trends and strategies.

And because there is no substitute for Silicon Valley, artificial limits on growth in Silicon Valley may prove very economically costly. Over the long term, the investments that aren't being made become innovations and business models that aren't realised and that hold back potential growth. In the short term, however, a boom that might have translated into very rapid job creation in the Bay Area, hasn't.**

The question, of course, is what to do about this problem. One might just hope that awareness of this dynamic will increase such that other companies come to join Google in pushing for a less onerous zoning code. Alternatively, cities could take a lesson from other arenas in which contentious politics threaten to undermine growth. Law professor David Schleicher argues, for instance, that city planning could learn from the long process of international trade liberalisation. When tariffs are reduced there are net economic benefits, but these are spread across many different individuals. The costs of liberalisation fall heavily on concentrated groups, namely, those working in previously protected industries. Those groups have a strong incentive to oppose liberalisation. If the institutional environment is set up to empower such groups, trade liberalisation will inevitably fail to materialise.

Similar dynamics apply to local development. If zoning decisions are made at a hyperlocal level, then groups that are located close by new deveopments, and who therefore face high costs relative to the benefits of growth, will be willing and able to veto new construction. This is frequently a problem in a Bay Area divided into scores of tiny cities. If more decisions are made at a higher level, however, like for the metropolitan area as a whole, then policymakers will care much more about the net benefits of development and should be correspondingly more likely to approve new growth.

Trade liberalisation also suggests that it's useful to give those with much to lose a financial stake in change. Trade-adjustment assistance acts as insurance against the worst outcomes of trade liberalisation. Similarly, governments could use a portion of the tax-revenue gains from new development to offset the tax burdens of those in close proximity to that development. That would give neighbours a financial incentive to approve, or at least minimise opposition to, new development.

America's latest tech boom is yet more proof that the world's largest economy hasn't lost its ability to create innovative new products that appeal to people the world over. It also helps illustrate, however, that the rickety economies of Europe aren't the only ones that could stand to use a little structural reform. More development in the Bay Area won't bring back the roaring 1990s. It does represent one easy way to improve the quality of job creation and growth in the American economy.

* Some urbanists claim that it's important to cultivate the "right" density to boost innovative activity, and that tall buildings aren't compatible with this. See this recent Richard Florida piece as an example. This strikes me as mistaken on multiple levels. I have very little confidence in the ability of planners to understand what a particular density is accomplishing and whether the "interactions facilitated" by shorter buildings either exist or are large enough to offset the higher real-estate and labour costs to which they contribute. It does not appear that technology companies have had trouble colonising central San Francisco or New York, despite the significantly greater verticality of those places relative to, say, Mountain View. And space is mostly fungible. Even if we assume that tech companies prefer short buildings while professional firms and households are happy in tall ones, the failure to provide ample supply for the latter uses will crowd out some of the former. That is, maybe the construction of lots of new residential and office highrises in San Francisco doesn't attract a single tech firm to the new towers. The new construction will nonetheless place substantial downward pressure on rents, attracting lots of new people to the region and making it easier to start a business.

** This is, at its heart, a microeconomic argument. I am not saying that restrictions on development in Silicon Valley have kept America's unemployment rate higher than it would otherwise be. The pace of improvement in the national unemployment rate is determined by national macroeconomic policies, and primarily by the Fed. Faster job growth in Silicon Valley would have closed America's output gap faster, thereby triggering, in all probability, a more hawkish posture from the Fed. That, in turn, would limit recovery to the Fed's preferred path. From a macro perspective, Silicon Valley restrictions may have forced the Fed to work harder to raise employment, which then appears elsewhere—in New York's financial sector, say, or in Ohio factories. My argument is primarily about the quality of growth. In my view, restrictions on growth in Silicon Valley affect job quality and the pace of growth in real output, productivity, and wages. I suppose one might say that America should have had a "better" recovery, according to this story, though not necessarily on in which unemployment falls faster. To get that, we need to see a bit of innovation in monetary policy.

The last guy I met from California had fairly radical views - he wanted an independent nation of California, complete with its own currency.

He was fairly frustrated with the massive fiscal transfers that California makes to the rest of the union, and has made for decades.

His opinion was that an independent California would quickly end the war on drugs, pursue a more liberal justice system in general, provide universal healthcare, wouldn't get involved in international wars, and would generally enjoy greater prosperity than the rest of the country.

Sounds like you had an encounter with a Berkely resident. ;)
An independent California would be a welcome development for the residents of many neighbor states that would relish the chance to block the flow of California refugees flooding their communities. :D

A shift towards development-focused policies that can "steam-roller" NIMBY would do wonders in the energy sector.
For all the whining about oil speculators raising gasoline prices, the biggest factor in price spikes is refinery undercapacity. It's been what, 30? 40? years since the last US refinery was built?
It wouldn't be hard to prove a significant *national* GDP benefit from even *one* new refinery (Delta airlines is even mulling buying one to assure their fuel supply) but getting past the kneejerk reaction from the NIMBYs is a hopeless cause; the laws and the legal system are too skewed towards the obstructionist minorities.
Things will likely get worse before the laws get changed to level the playing field.

Never mind the lost job potential for the US as a whole; California itself is drowning in red ink because of its decreased tax revenues. That should be all the incentive they need to accomodate job creation.
Yet it isn't.
Of course, it has been suggested California is now incapable of governing itself.

Your argument that legislative constraints on real estate development have:
1) constrained workforce and employment expansion (both in tech and in ancillary services)
2) brought about rising rents and inflated prices for non-traedable goods and services
3) weakened pace of productivity growth, by impeding expansion of some of America's most productive and innovative entities

is bang on the mark! Policy makers need to take note of this - California needs to stop shooting golden-egg-laying geese!

On the macroeconomic front, you've got it backwards. Artificial supply constraints in the Valley have - throughout this recession - contributed directly to inflationary pressures. Rapidly rising prices of take-out food in Palo Alto (the business has to pay extortionate rent, and competitors can't get the premises or license to open) add to measured inflation across the US. This would cause the Fed to impose tighter monetary policy than otherwise.

On the other hand, real estate liberalisation in the Valley would:
1) short term: cause a construction boom, which would directly utilise unused capacity and increase GDP whilst also increasing state and federal tax revenue. This wouldn't even be inflationary in the short term, since there is massive unused construction sector capacity in California.

2) medium term: cause rapid expansion in production of both high-tech and ancillary services/ non-tradeables. This means higher employment, and higher productivity nationally as resources are shifted from less productive parts of the country. Furthermore, increased capacity and competition would cause local price depreciation and convergence towards national price levels, which would allow the Fed to pursue a more expansionary monetary policy.

3) long term: as you state in your article, more people in Silicon Valley means more high-tech innovation, business formation, business expansion and national productivity growth.

You've already given us the main policy prescription: smaller polities/ cities must be aggregated. Now. Perhaps some process reform is also needed (e.g. presumption in favour of development). Perhaps a state level appeal/ arbitration process that is capable of steam-rolling local NIMBYs if a case is made that a development has sufficient economic value, and if reasonable local environmental concerns are adequately addressed.

Who says silicon valley hates development? The residents of Santa Clara, none of them named Steve Jobs, recently chose to spend millions of their own tax dollars to build a giant ring of their own. This one will consist of 60,000 hard plastic chairs surrounding a lovely 100'x300' patch of grass, surrounded in turn by large, tall high density accommodation...for automobiles. The whole contraption will allow out of towners to drive in, drink beer, and watch 22 men chase a football for 60 minutes x 8 Sundays every year.

That, according to the local electorate, is the kind of development worth paying for. Apparently, the locals find all the new concrete, traffic, trash, noise and light pollution perfectly acceptable as long as they come with cheerleaders. Smart people, those voters.

Ryan, excellent post, as always. I think this also has important short-term implications for monetary policy. We know that as the housing sector begins to recover, rents and house prices are going to start rising again (perhaps briskly, given the shortage from a near-complete lack of construction over the last several years). I think you (or maybe it was Karl Smith) pointed out that the Fed's insistence on 2-percent inflation as a ceiling could complicate what should otherwise be a perfectly natural part of the recovery. Obviously local land-use regulations are a big factor in determining how quickly recovering demand for housing will translate into higher prices. Loosening those regulations could help relieve the inevitable upward pressure on housing prices and give the Fed a bit more breathing room before it hits that 2-percent ceiling. Of course, those regulations are made at the local level, so it's not clear this can be done in a concerted way.

here's the thing though...i just looked at CoStar's listings for commercial and flex spaces in Santa Clara county and see a vacancy rate above 40%.

Are all of these buildings suitable for tech? I can't say for sure but a bit of tenant improvement work could certainly bring many of them up to the appropriate level.

Are these buildings the right size for big tech? not by a longshot but many are in perfect spots for redevelopment into residences and are located in cities that are falling over themselves to approve projects left and right.

The upshot is that the Bay Area is not supply constrained. The problem is that there is no more low hanging fruit - at least not by the conventional measures of the past. Nevertheless opportunities remain and I only wish I had the capital to take advantage of some of them.

That is a false choice. As the article stated, many people at Google, FB and elsewhere prefer to live in more urbanized environments, even if that makes their commute longer. In other words, density offers superior "economic efficiency" AND "ambiance and quality of life".

This sentence "Houston, in other words, got about twice as much private job growth out of its technical job growth in comparison with San Jose" and the next one imply a relation between technical jobs and the other jobs added. You never examine the implication you draw. Why not? The obvious response is there is no major relationship between the kind of professional job growth you see, that the 5k to 30k total for San Jose speaks to a different job market than the 7k to 90k for Houston. You then hang an entire argument about land development on an implication you assert without discussion, without evidence and in the face of lots of data that says Texas adds lots of jobs associated with population increase, many of them low paying.

You set aside the well discussed facts about how Texas grows in order to make a point about development restrictions. That is intellectually wrong. You also assume that reducing development restrictions would increase the kind of jobs Texas attracts. Maybe. Maybe it would do even better, meaning more higher paying jobs, increasing the ratio of professional job growth in San Jose even higher. But you can't really talk about that clearly because your foundation is a mess.

You might have mentioned Apple's new HQ. They attacked the same problem Google faces: lots of older buildings, lots of surface parking lots, inefficient organization rooted around grid access, etc. They didn't really increase density but rearranged space to make a much bigger building surrounded by a large amount of green. They moved some parking underground (with some in existing areas off that site).

It is, essentially, a circular problem. If Google (for example) could get approval of its alternative development plans, more Google employees would live there. If they lived there, their votes would push the city council to approve projects to allow the development plans.